ELSS : Save tax with mutual fund investments…

As we are nearing the end of the Financial Year there has been a spurt in activity with regard to tax saving investments. Investments are potentially your second income & security for a better future & thus should be planned carefully so that poor investment choices are not made. But all said it is human nature to wait till the last moment & then act in haste to complete your tax saving formalities. Thus many tax payers are currently looking for various options to save income tax u/s 80C. While there are several options, one of the attractive avenues is tax saving mutual funds known as ELSS.

ELSS or tax savings funds provides tax savings u/s 80C upto a maximum of Rs.1,50,000/year. Tax saving MFs has the potential to give significantly higher tax free returns as compared to other investments like life insurance, tax saving FD, PPF, NSC etc; ELSS has a lock in period of 3 years as compared to 5-15 years for other products. Returns from ELSS could on an average be about 12-15% but could also be higher in better market conditions as compared to 7-9% for other investments. A point to note here though is that more than 65% of the portfolio consists of equity investments & thus these returns are not guaranteed.

Who should invest…

ELSS is advisable for investors with moderate risk taking ability wanting to invest in equities while also enjoying tax benefits on the same. This can be a good investment for a new investor as it will give them exposure to equity markets and the lock-in period will ensure they maintain fiscal discipline. One of the best ways to invest in equity fund is via SIPs as it negates the timing risk of investment and irons out market fluctuations as discussed by me in an earlier article. Before investing in any fund one should check the fund manager & fund’s performance and the portfolio of the fund.

What are the potential returns…

It has generally been seen that in the long run equity markets generate about 14-15% returns & thus we can safely assume that ELSS should give about 12-14% returns in the long run given that it may invest a part of its investments in debt funds also. But these returns are not guaranteed & could be higher or lower depending on overall market conditions. ELSS is mainly compared to NPS (National Pension Scheme) & ULIPs ( Unit Linked Insurance Plan). ULIP is an insurance plan & invests the premium paid (after various deductions & charges like agent commission & mortality charges etc) in either equity or debt & most ULIPs have a lock in period of 10 years or more. Thus the actual amount invested especially in initial years could be significantly lower than the premium paid. NPS, on the other hand, is a retirement solution and not exactly a savings option. It may have limited exposure to equity depending on the plan and lock-in period is generally extended till the investor’s retirement. Also, lump-sum withdrawal can be taxable.

To conclude…

Though ELSS has a mandatory lock-in period of 3 years, it is not compulsory to redeem the amount after maturity and the investor can continue with the investment as long as he wants & maybe wait till he gets favorable market conditions to withdraw the amount. As discussed in earlier articles, in the short run markets may decline and fluctuate but in the long run market returns mirror economic growth of the country which would be the cumulative of GDP growth & inflation. We expect this to be between 14-15% on an average going ahead. Among all tax saving investments this is the only investment which accounts for inflation in its returns. When one takes inflation into account, traditional investment routes are sub-optimal due to the fixed interest rates and the falling value of the rupee. Real returns post inflation would generally be in low single digits.

The best course of action is to check the amount you are left with of the Rs 1.50.000 Sec 80C limit at the start of the year, divide it by 12 and start a monthly SIP of the amount immediately.

Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 9 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’